Wednesday, May 12, 2010
Credit Default Swaps Are Unveiled
Since the waterfall effect created in the stock markets in October of 2008, I have remained wary of the lack of visibility of the credit default swap (CDS) market. This is another 800 pound gorilla in the room, and I am concerned that I cannot see any sign of it. These derivative securities were a major influence in how rapidly stock and bond prices shed value and I cannot forget that. Companies (primarily the foreign and domestic 'too big to fail' entities) that used them for protection suddenly found they were unprotected and suffered large, unexpected losses, repeatedly. Thanks to a swift accounting rule change and federal bailouts to cover realized losses and build up reserves for future losses, their losses were only temporary stock price declines that have almost completely recovered. This may have something to do with their complexity. But their complexity has not prevented Ron Hera from taking on the investigative task and having his article published on Financial Sense. Hera has written what I think is the best review of the CDS world I have found and I want to refer to it in the future. Here is the link to "OTC Derivatives: Failed Banks or Failed Nations?"